Why Tech Stocks Are Regaining Their Mojo

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 |  Includes: EMC, HPQ, IBM
by: Wall St. Cheat Sheet

By Elliot Turner

Technology is about growth and innovation. Companies labeled “tech stocks” are not limited to Internet sites and computer makers, but rather, a tech company is one that does old things in new ways, or one who offers completely novel ideas and products never before seen. I love innovation, gadgets and the process of playing with and exploring new gadgets and incorporating them into my everyday life. My willingness to embrace technologies has afforded me the opportunity to remain in touch with the latest trends and ideas that deserve the attention of consumers and investors alike.

The transformative change that the Internet so wondrously embodied to investors in the late 1990s is now coming to fruition in our everyday lives. We are a perpetually connected society who consumes everything ranging from books to shoes to media on the World Wide Web. At this very moment, there are rapid changes taking place in the devices we use to connect to the Internet and how we go about using them to streamline our connectivity and web-based consumption. Just about everyone now has a smart phone or some other netbook/iPad device to check their emails, send text messages and tap into the latest spate of entertaining music, movies and viral YouTube videos.

While the Tech Sector is primarily about selling new ideas, there is an investment element in the technology space that many continue to overlook: incredible valuation metrics. The bursting of the dot.com bubble and the subsequent financial crisis left many investors scarred and wounded. Still rattled from some of the massive losses from the early part of the 2000s, investors have been relatively skeptical and reluctant to get overly involved with tech stocks and as a result, they are missing out. I have always had a preference for investing in growth, yet when you add in this valuation element to the Tech Sector it offers a wide array of opportunities for various levels of risk tolerance.

The companies who survived the dot.com bust took to heart the lessons learned from their peers’ failures. During the stock market’s ascent from 2003 to 2007, many tech stocks lagged the broader markets; however, during that time these companies built up outstanding balance sheets. This is the essence of capitalism: the best ideas, with the strongest management teams built solid, long-lasting foundations that are now thriving while those that failed no longer exist. Many of these companies entered the financial crisis with robust cash positions and little to no debt. This left them in an outstanding position to both weather the storm of the debt crisis and to engage in a spate of strategic acquisitions in order to boost their existing revenue streams.

The macroeconomic climate remains challenging and volatile and there are serious macro risks to consider when investing in any company right now that are not necessarily company or industry specific. At its essence, we are living through a severe, rolling credit crisis that despite the aggressive recovery in the stock market indices, continues to weigh on our economy and impact the strategic decision making of debt-laden companies. We are in the midst of a secular shift from credit expansion to credit contraction and those with too much debt exposure will suffer the consequences.

One way to mitigate the macro risk is to understand the nature of this crisis and pursue investments accordingly by focusing on companies and sectors with strong cash positions and little to no debt. For the more aggressive investors, there are also opportunities to seek catalyst-driven investments in debt-riddle companies in which one can identify an opportunity for the company to restructure and move past the burdens of heavy indebtedness.

When a sector on the whole, like technology, is so rich in cash it subtly places a bid under the share prices of its respective companies. This leads to more M&A, share buybacks and the creative use of cash for shareholder benefits. Around the market bottom in 2009, we saw tech giants like Hewlett-Packard (NYSE: HPQ) buy both EDS and 3Com, IBM (NYSE: IBM) purchase Sun Microsystems, and EMC (NYSE: EMC) acquire Data Domain, among others.

It is far from coincidental that the first wave of significant M&A during the debt crisis occurred in the most cash-rich and fastest growing segment of our economy. These companies did not need to secure financing to complete these acquisitions and were able to take advantage of suppressed asset prices in order to integrate and expand upon their existing suite of products. While the eye of the debt storm may have passed, credit market volatility creates risks that just are far great outside the tech sector than within. It is our job as investors to position ourselves accordingly.